United States District Court, Southern District of New York
October 23, 1990
VIGILANT INSURANCE COMPANY, PLAINTIFF,
C. & F. BROKERAGE SERVICES AND M. & M. INSTITUTIONAL SERVICES, INC./BROADWAY ENTERPRISES, INC., SAL FONTANA, CHARLES CHIARAMONTE AND FRANK PROCIDA, DEFENDANTS.
The opinion of the court was delivered by: Kevin Thomas Duffy, District Judge:
MEMORANDUM & ORDER
Plaintiff, Vigilant Insurance Company, ("Vigilant"), brings
this action claiming violations of: (1) § 10(b) and rule 10b-5
promulgated thereunder, of the Securities and Exchange Act of
1934 ("1934 Act"), 15 U.S.C. § 78j (1982); (2) 18 U.S.C. § 1961
et seq. of the Racketeer Influenced and Corrupt
Organizations Act ("RICO"); (3) common law fraud; (4) common
law conversion; and (5) for money had and received. Defendants
are C. & F. Brokerage Services ("C & F"), M. & M. Institutional
Services, Inc./Broadway Enterprises, Inc. ("M & M"), Sal
Fontana, Charles Chiaramonte and Frank Procida, (collectively
the "finders"). Only one defendant, Frank Procida, a principal
of C & F, moves to dismiss counts 1-5 and 7-8 of the amended
complaint.*fn1 Vigilant cross-moves pursuant to Fed.R.Civ.P.
15(a) to further amend the complaint to add Ralph Anselmo as a
defendant, to enter a default against M & M, and to sever and
continue the action as to the remaining defendants.
Vigilant, a New Jersey corporation, insures M.J. Meehan & Co.
("Meehan"), a partnership with its principal place of business
in New York, against losses occasioned by employee dishonesty.
Meehan is a New York Stock Exchange specialist firm engaged in
the buying and selling of only specific securities that are
listed on the exchange, which insures a continuous trading
market in those securities. C & F is a New York corporation. M
& M is a foreign corporation which has its principal place of
business in New York. Both C & F and M & M are companies which
arrange stock loans with other brokerage firms. Meehan enlisted
C & F and M & M as "finders," namely, middle-men, to obtain
stocks from other brokerage houses in order to fund Meehan's
commitments to its own clients and cover its position in the
market. In turn, Meehan provides cash collateral to the finders
for the loans. Once Meehan covers its position in the market,
it returns the stocks and receives back the collateral. In
addition to receipt of its collateral, Meehan is supposed to
get an interest payment, or "rebate." Meehan claims that it
never received proper rebates in the aforementioned finder
Meehan alleges that C & F and M & M schemed to defraud it of
rebates on its stock borrowings and loans. Fraud is posited
under three federal statutes: mail fraud (18 U.S.C. § 1341);
wire fraud (18 U.S.C. § 1343); and securities fraud (18 U.S.C. § 1961
and 15 U.S.C. § 78j). Each type of fraud constitutes the
basis for a predicate act under RICO.
Rule 9(b) of the Federal Rules of Civil Procedure, read
together with rule 12(b)(6) requires that allegations of fraud
be made with particularity. This is to insure that a defendant
has fair notice of the claim, to protect a defendant's
reputation and goodwill, and to reduce the number of strike
suits. Di Vittorio v. Equidyne Extractive Industries, Inc.,
822 F.2d 1242 (2d Cir. 1987). The complaint must specify the time,
place, speaker and content of the alleged fraud. Luce v.
Edelstein, 802 F.2d 49, 54 (2d Cir. 1986). When there are
multiple defendants, allegations of fraud may not usually be
made collectively, but in this case where the individual
defendants, including Procida, were principals of C & F and M &
M, claims may be made collectively. See Ballan v. Wilfred
American Educational Corp., 720 F. Supp. 241, 253 (E.D. N Y
1989) (fraud in SEC filings may be collectively alleged as to
principal and inside directors).
Vigilant alleges that, in each transaction, an agreement was
made whereby money was fraudulently retained by C & F and/or M
& M through one or more principals or agents. Specifically, it
is alleged that from January 1982 to March 1984, C & F engaged
in a scheme to defraud Meehan
by conspiring with certain of its employees to fraudulently
retain rebate monies owed after Meehan returned the collateral.
Vigilant believes it is entitled to proceed against Procida and
conduct discovery because knowledge and participation in the
scheme to defraud Meehan can be imputed to him. Plaintiff's
Memo at 4, Complaint ¶¶ 22 et seq. Procida contends, however,
that these allegations, based upon information and belief, are
insufficient to create personal liability.
Individual liability will attach if the corporate principal
was personally connected with the wrong. Brunswick Corp. v.
Waxman, 459 F. Supp. 1222 (E.D.N.Y. 1978), aff'd, 599 F.2d 34
(2d Cir. 1979). In the case at bar, it is alleged, albeit
sketchily, that Procida was personally involved in the scheme.
[i]n the case of a small corporation, where the
boundaries between the corporate entity and the
individual director are often permeable, it cannot
be said as a general rule that allegations
sufficiently directed against the corporate entity
fail to detail, for purposes of Rule 9(b), the
actions of its director with sufficient
particularity. Nor does this contravene the
rationales for Rule 9(b). Currie v. Cayman
Resources Corp., 595 F. Supp. 1364, 1372 (N.D.Ga.
1984), aff'd in part and rev'd in part,
835 F.2d 780 (11th Cir. 1988).
It is permissible to plead upon information and belief when
the facts necessary to state a cause of action are wholly
within the control of the party who is alleged to have
committed the wrongdoing, for it would be unfair to allow a
party to escape liability merely because a principal employee
forms an impenetrable barrier concealing details of the fraud.
Luce v. Edelstein, 802 F.2d 49, 54 n. 1 (2d Cir. 1986). This,
however, necessitates the inclusion of facts upon which the
belief is founded. Id. In this case a sufficient statement of
the facts is included in the appended statement by William
Meehan as to his investigation in the matter. The corporate
structure of C & F and the extent to which Procida controls it
are matters which are critical in determining liability in this
case. Information regarding these matters is wholly within the
control of Procida and C & F. Therefore, I find Vigilant has
sufficiently stated facts to support its contentions in the
amended complaint and attached sworn statement to preclude
dismissal at this juncture. Vigilant is hereby given leave to
proceed with discovery.
Turning now to Procida's claim that the securities law frauds
must be dismissed, I note that Vigilant's fifth cause of action
alleges violations of § 10(b) of the Securities Exchange Act of
1934 and rule 10b-5 promulgated thereunder. These provisions
prohibit making false and misleading statements "in connection
with the purchase or sale of any security." (emphasis added)
The purpose of § 10(b) and Rule 10b-5 is to protect
persons who are deceived in making securities
transactions — to make sure that buyers of
securities get what they think they are getting and
that sellers of securities are not tricked into
parting with something for a price known to the
buyer to be inadequate or for a consideration known
to the buyer not to be what it purports to be.
Chemical Bank v. Arthur Andersen & Co.,
726 F.2d 930, 943 (2d Cir. 1984), cert. denied, 469 U.S. 884
[105 S.Ct. 253, 83 L.Ed.2d 190] (1984).
The Act is directed at fraud which relates to the value of the
securities transaction as an investment. Therefore, to
adequately state a cause of action, the misrepresentation must
relate to the value of the security. It is clear in the case at
bar that the fraud involved stock borrowings and loans.
Specifically, Vigilant alleges a scheme whereby C & F and M &
M deprived Meehan of interest on the collateral for stock
loans. Thus, the fraud alleged regards retention of interest on
the collateral and a diversion of proceeds, neither of which
affects the worth of the stocks. Since the investment value of
the stocks were not affected, the "in connection with"
requirement is not satisfied.
Moreover, Vigilant misread the Supreme Court's opinion in
Superintendent of Ins.
v. Bankers Life and Casualty Co., 404 U.S. 6, 92 S.Ct. 165, 30
L.Ed.2d 128 (1971). In that case, the court held the "in
connection with" requirement satisfied where a plaintiff was
duped into believing it would receive the proceeds from the
sale of bonds. This proposition, however, does not include the
misappropriation of the interest owed on collateral for stock
loans as is alleged here. Because "[t]he crux of the present
case [i.e. Bankers Life] is that [plaintiff] suffered an injury
as a result of deceptive practices touching its sale of
securities as an investor," it is thus distinguishable from the
instant case. Id. at 12, 92 S.Ct. at 169 (emphasis supplied).
Likewise in S.E.C. v. Drysdale Secur. Corp., 785 F.2d 38 (2d
Cir. 1986), cert. denied, 476 U.S. 1171, 106 S.Ct. 2894, 90
L.Ed.2d 981 (1986), the court held that misrepresentations
regarding the financial condition of a company involved in
"repo" market transactions*fn2 was "in connection with" a sale
of securities. Again, in that case, the court emphasized that
the "misrepresentation clearly pertained to a significant part
of the consideration offered . . . part of the consideration
offered by [defendant] was a promise — in repos to repurchase
and in reverse repos to resell — that its insolvency rendered
worthless . . . (defendant's) financial strength was essential
to the value received by the other party in a securities
transaction." Id. at 42 (emphasis supplied). In the case at
bar, however, the fraud occurred after the transaction was
complete. It was not related to the investment value of the
security. As such, the conversion of rebate interest on
collateral deposited for borrowing securities does not state a
cause of action under the securities laws. Having failed to
allege the requisite "connection" with "the purchase or sale"
of a security, count five is dismissed.
Finally, Vigilant seeks leave to amend its complaint to add
Ralph Anselmo as a defendant. It is axiomatic that the Federal
Rules of Civil Procedure provide for liberal amendment of
pleadings. As such, Vigilant may so amend its complaint.
For the foregoing reasons, only count five is dismissed. The
complaint otherwise survives in its entirety. Vigilant is
granted leave of court to amend its complaint, adding Anselmo
as a defendant. Additionally, Vigilant seeks a default as
against M & M and Broadway for failure to answer or move with
respect to the complaint. Vigilant is hereby directed to submit
the appropriate default judgments within ten days of the date
of this order.